Wooing debt FPIs via voluntary retention route

In a bid to make buy-and-hold investments in Indian debt more alluring to Foreign Portfolio Investors (FPIs), the RBI has made a new set of relaxations to its voluntary retention route (VRR) mooted in March 2019. The VRR route had waived residual maturity and concentration norms for FPIs who committed to holding their Indian bonds for a minimum period of three years. The latest set of relaxations double the cap on investments through this route to ₹1.5 lakh crore from ₹75,000 crore, make these quotas available on tap and allow FPIs to buy debt Exchange Traded Funds. While these relaxations do expand the headroom for FPI participation in Indian bonds when market conditions are supportive, it is doubtful if they will have FPIs making a beeline for India when market conditions are hostile as they are today, with rising inflation and threat of a fiscal deficit overshoot. In fact, FPIs have so far chosen not to use up even the existing VRR limit of ₹75,000 crore, investing just ₹54,300 crore by December 31, 2019.

Unlike India’s equity market, which has managed to attract sovereign wealth funds, pension funds and other categories of stable, long-term foreign investors in the past decade, the debt market continues to draw in sizeable hot money. FPIs were net investors in Indian debt for just three of the last seven years, while they were net sellers in four. This high variability of inbound FPI flows seems to arise from the fact that a good proportion of foreign investors who are presently betting on Indian bonds merely view them as a short-term arbitrage opportunity on global interest rate differentials — borrowing money at rock-bottom rates back home and deploying it at higher rates here. Given that these arbitrage gains can be wiped out by rate moves or currency volatility, these FPIs have turned out to be fair-weather friends — buying into Indian bonds when rates are high and the currency is stable and rushing for the exit doors the moment these conditions reverse. This is the trend the VRR route is seeking to reverse.

There are no doubt many advantages to higher participation by long-term FPIs in India’s debt market. They can offer a more diversified investor base for government bonds, aid corporate deleveraging and help create the market for lower-rated bonds that India sorely lacks. But policymakers also need to brace for the fact that foreign investors are unlikely to take as benign a view of the fiscal situation or corporate debt defaults as domestic lenders and will likely pull the plug without compunction. FPIs, on their part, will be looking for a fool-proof legal framework on contract enforcement and expeditious recovery, fuller rupee convertibility and the flexibility to transact without too many rules, apart from a better sovereign rating for India. Getting the domestic house in order on these aspects must precede any attempt to woo long-term FPIs.

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